‘Need investment alternatives to Gold’

MUMBAI: A Reserve Bank of India panel has brought to the fore the harm that enormous gold imports can cause the economy, but said the answer lies not in just curbing the demand but in providing alternatives that yield real returns, adjusted for inflation.

The panel has suggested many measures, including taxes and capping of the quantum of imports by banks and others such as MMTC. It also favours gold-backed financial instruments. Much to the relief of non-banking finance companies, it said lending with gold as collateral should be expanded with banks increasing their gold loans portfolio.

"The current trend in the quantum of gold imports appears to be making India's external sector vulnerable in terms of rising trade and current account deficits, which in the absence of adequate foreign capital flows, can have implications for maintaining adequate foreign exchange reserves buffer," said a draft report of the Working Group to Study the Issues Related to Gold Imports and Gold Loans by NBFCs headed by KUB Rao.

"While we coped with such large imports, so far, if this trend continues gold imports will have adverse implications for the external sector management, as export performance is not robust," it said. Policy-makers in the country are rattled by the soaring gold demand which has pushed the current account deficit, which has touched a record 5.4% of the gross domestic product.

Investors are chasing it (gold) as other investments including equities and fixed deposit returns turned adverse. Indeed, the returns from bank deposits were negative — deposit growth is far below the central bank's desired level. High inflation for more than three years led to negative returns from fixed income securities. "We may be left with no choice but to make it more expensive to import gold," said finance minister P Chidambaram.

Gold contributes to nearly 30% of the trade deficit. About 10% of world's gold is in India's possession , says the World Gold Council. Accumulated gold stock in India is around 18,000 to 19,000 tonnes as per independent estimates. During 2002-2012, the annual gold demand remained stable at between 700 and 900 tonnes.

It is inflation which is the culprit behind the high demand for the precious metal. "The dominant reason why a person may like to hold his savings in the form of gold is to hedge against inflation," it said. "Therefore, offering a real rate of interest as an incentive on a financial instrument would better address the issue of excessive clamor for gold imports." Any attempt to curb it without alternatives could fail, it said. "The Group recognises the fact that choking supply channels cannot be an appropriate way to reduce the demand unless under compelling circumstances. We need to address the excessive demand issue."

To divert the attention of people from buying gold, the panel has suggested various financial savings products. "There is a need for banks to introduce new gold-backed financial products that may reduce or postpone the demand for gold imports ," the panel said. "Awareness would play an important role in popularising these instruments." Instruments like gold accumulation plan, gold-linked account, modified gold deposit and gold pension could be considered for investment.

The challenges for these products would be to offer higher returns and provide adequate liquidity. The committee suggested allowing exchange traded funds to invest their gold holdings in gold certificates with banks and modalities could be worked out with the capital markets regulator. Attempts to control consumption could also lead to blackmarketing which the liberalised India wanted to avoid.

"If there is an increase in import duty and gold-linked financial products come in, black market for gold will start," said Gnanasekar Thiagarajan, director Commtrendz Research. RBI took a number of measures to discourage investment into the precious metal in the recent past. It banned banks from funding gold-buying by gold loan companies and reduced the lending capacity of gold financing NBFCs from 70% of the value of gold.